The subject of personal finance
is very broad, but as a beginning, I would like to discuss
what I consider the foundations of personal finance: Security,
Stability, Growth and Protection & Management.
Security
Security to me means that I am prepared for the "hit by a bus"
scenario.
I have life insurance to provide for my wife and children.
Health, disability, auto and home insurance policies also
provide me additional protection in their respective areas. I
also have a list of where these policies are, who my agents
are, phone numbers and basic policy information (#s, amounts,
costs, etc.) I keep this information both in a file at my
house and in a safety deposit box at the bank (a friends home
will also work - think: "house burns down" scenario). Also my
wife and my brother and sister-in-law who live nearby also
know where these things are.
I also try to maintain an emergency fund of cash in a bank
account or money market account (with checks) so that I am
prepared for a financial disaster, layoff, or natural
disaster. It took several years to build up this cash fund. I
started with a goal to have enough cash for 6 months of my
normal financial needs (mortgage, food, insurance,
transportation, etc.). Now I am trying for 12 months' worth. I
do this by saving a little each month, and "investing" a
portion of all "found" money (gifts, inheritances, tax
returns, anything unexpected).
I have a will and update it each year around New Year's to
reflect any changes in my life during the past year (new
children, new home or business, etc.). Most people don't need
an extensive will, the forms you buy at your office supply
store will do. But in some states if you die without one,
watch out. What happens to your money and even your children
could be entirely up to some state or court appointed
official.
Stability
The next level of personal finance is stability.
Stability to me means that first of all I live within my
means. I don't spend more than I earn. Otherwise I am spending
my savings, investments, emergency money, or getting into
debt. I have a lot of debt, but most of it is real estate
which is producing some income. I try to avoid credit card
debt and purchase everything with money I already have. I
don't buy things expecting that next month I will have more
money or I will get a big raise or promotion. You can't sell
me a car based on a monthly payment amount; I want to know the
final price!
In order to make sure that I am living within my means, I
created a simple budget and I track my expenses using Simple
Joe's Expense Tracker. I can tell how much I have spent in
each budget category and I know when to keep a closer eye on
certain types of expenses, or when and where I can cut
expenses and what I can live without in order to stay within
my budget. Counting pennies is pretty tedious, but tracking
where the dollars go can be eye-opening.
Another aspect of stability is avoiding or eliminating debt.
Debt in itself is a form of stability; you always have to make
those payments until it is all paid off.
Some recent reports show that the average American is $7,000 -
$20,000 in debt. Most of it is consumer debt: credit cards,
store accounts, rent-to-own, auto loans, etc. And those types
of consumer debt usually charge a higher interest rate than
any savings account, CD, or money market account; even more
than most high-flying risky investments.
This means that $1,000 in debt at 18% is costing you 9 times
what your $1,000 savings account at 2% is producing. Consumer
debt is a dangerous spiral that is very hard to get out of.
The first problem is, as mentioned before, living within your
means. Don't get further into debt to support an extravagant
lifestyle. Or even if you are frugal, if you are using credit
cards and debt to finance your purchases, you either need to
stop purchasing luxury items or find a way to increase your
income to support these purchases/payments.
You may even have to lower your standard-of-living because you
have racked up considerable debt and need to free up some
money to pay it down. But don't wait to start. Those minimum
payments are often designed to keep you paying 18% interest
for 40 years! That's longer than most home loans. You could
even end up paying more than 10 times the original cost of the
item just in interest payments. Is that new stereo really
worth that much?
To help people get themselves out of debt we created the "Pay
Off My Debts" tool in Simple Joe's Money Tools. It is also
available as a stand-alone product called Simple Joe's Debt
Eraser. These tools help you create a Rapid Debt Reduction
Plan which shows you how much to pay on each debt each month
in order to save as much on interest charges as possible and
pay off your debts as soon as possible.
These tools can help you systematically eliminate your debts
whether you owe $1,000 or $100,000. The key is to start living
below your means and start focusing on paying off your debt.
It doesn't make much sense to be worried about whether or not
your 401k earns 8 or 9% this year, if you are paying 21% on
your credit card debt.
A third aspect that starts in the stability category and
transcends to the next personal finance level, growth, is the
concept of investing in yourself. By this I mean spending time
to educate yourself in personal finance matters, as you are
doing right now and spending time gaining more knowledge and
improving your skills or even developing new ones.
As an employee, this can have a direct relation to who gets
laid off during the next round of cutbacks. If you have some
skills or have demonstrated some abilities that are not
possessed by your co-workers and these skills make you a more
valuable employee, you are less likely to get the pink-slip.
Also while you are making yourself more valuable to your
current employer, you are also making yourself worth more to
future employers. It is much easier to land a job if you have
some special skills that are in high demand or even if you
bring some special knowledge or experience that you fellow
job-seekers may have overlooked or failed to invest in.
Being in the computer industry, I have to spend hours each
week reading trade magazines, exploring web sites, and reading
emailed newsletters to keep abreast of what is new in my
field. If I stopped learning just five years ago, I would have
missed out on the Internet revolution, email, web sites and
the majority of the income I now enjoy.
Keeping myself informed and up to date takes time and
resources, but it helps me protect my current income and
expand my skills to help me earn income in other areas. This
increases my stability by allowing me to not have to rely on
one client, employer or source of income. A chair with four
legs will always be more stable than a stool with only three.
Growth
The next level of personal finance, as I alluded to before, is
growth.
Once you are secure and stable, you can begin to think about
building your wealth. Not that you have to figure out how to
become the next Bill Gates or Warren Buffet. But you have to
start building the "nest-egg" that you will rely on when you
retire.
And don't think that Social Security has you covered, or that
your 401k will grow back to what it was a couple years ago. Or
that your current employer is going to re-institute the
generous pension plans of yesteryear. 401ks are much cheaper
to administer and you, the employee, take the hit when the
market goes down, not the employer.
My father is nearing retirement age and I think he has a good
plan. He has done some research and estimated what his
expenses are going to be when he is retired. He then took a
look at his potential sources of income during his retirement.
He figured that Social Security would cover about a third of
what he wanted to live on. Only a third! And he has worked his
entire life. Would you like to instantly have to live on only
one third of what you currently make? Retirement is suppose to
be the golden years, so where's the gold?
Luckily throughout his career, my father has worked for
companies that have had pension plans and he had worked long
enough at each company to be eligible for some pension money.
This is rare these days because today the average worker will
change jobs and companies at least five times during his/her
career. Also, as I mentioned before, companies are switching
to lower cost 401k plans that do not guarantee you any fixed
payments.
In my father's situation, his pension money would cover
another third of the retirement income he wanted. So now he
had to either figure out where the last third was going to
come from, or start cutting out expenses during retirement,
like not visiting his children so much. None of us liked the
sound of that.
So my father started learning about the stock market and
investing in stocks and mutual funds. He made a plan for
growing his wealth and then educated himself as to how he
could accomplish his plan. I wish I could say that he is doing
better than he is, but luckily he has some time still to put
his plan into action and ride out any market downturns. (He
can do this because he has the security of insurance and
emergency money, and the stability of little debt and a strong
set of skills.)
By learning about how stocks, bonds, mutual funds, index
funds, options, futures, commodities, real estate and other
financial tools work you lay the foundation for growing your
wealth. You may start with just $100 in a bank CD, but as you
learn more and become more sophisticated, you can invest in
more and more opportunities.
You will learn about how risk and reward are related, that as
the risk increases so does the size of the potential reward.
Just like at the race track, you'll make more on the long
shot, but the odds are against it. Also you can learn how to
tilt the odds in your favor and protect yourself against risk.
For those who are just starting out in the growth phase or who
want to dabble a bit before completing the other levels of
personal finance, my suggestion would be to look into index
mutual funds. Especially no-load index funds (no initial/sales
fee).
These funds are made up of the same stocks that make up the
popular market indexes like the Dow Jones, S&P and NASDAQ100.
The costs are low because management is simple and as a mutual
fund you can invest a little at a time. Also they are easy to
follow since you see them on all the news shows and in the
newspaper.
Protection and Management
The final level of personal finance is the protection and
management of your wealth. Most people never develop wealth
enough to need this level. But some of the concepts can be
applied to any amount of wealth you possess, $10,000 to
$10,000,000.
Part of the protection harks back to your will as we discussed
on the first personal finance level: security.
With any significant wealth or valuable asset (your home, car,
heirlooms, 401k, IRA, business, etc.) you will want some way
of disposing of that asset upon your death. Whether it is go
to go your family, favorite charity, or local church, if no
one knows about it, "it ain't gonna happen".
As you start to accumulate wealth in excess of $350,000, you
may want to consult an attorney about creating a trust. A
trust is an entity that can own property and pass that
property to anyone you name in your will. Usually the trust is
designed to provide income to children from the assets that
are placed in the trust.
The trust can survive you so that your assets and income may
be passed on to your children or next-of-kin without excessive
taxation and legal entanglements. Some states will take up to
55% of your assets as taxes when you pass away.
Protection also relates back to insurance. Now it may be time
to look at a multi-million dollar umbrella policy that will
protect you from lawsuits designed to part you and your
wealth. You may now be a bigger target, so purchase a suit of
armor.
The management aspect comes into play where you may start to
concern yourself with taxation, ownership, distribution of
income and possibly endowments to charities or other
non-profit institutions.
You may hire a person or company to manage your wealth, or you
may choose to do it yourself. Most people who have earned
their wealth through the "sweat of their brow" have already
become adept at managing their assets. Some continue to
personally manage their wealth because of the enjoyment or
challenge it gives them.
Others are ready to turn it over to a trustworthy manager (who
only gets paid a percentage of your increase) and travel the
world, or sit on a beach and count the waves.
Whatever your dreams for retirement (and why wait until you
are 65), understanding the different levels of personal
finance and spending the time and resources to educate
yourself will pay off whether you live next to Bill Gates or
Homer Simpson.
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© Simple Joe, Inc.
Chemain Evans is a quality control
specialist for Simple Joe, Inc., makers of the popular Simple
Joe's Income & Expenses PC software. Income & Expenses is a
quick and simple way to keep track of your expenses and stay
within your budget.
Income &
Expenses is ideal for tracking personal, business, home and
club expenses.. This article may be freely distributed as
long as the copyright, author's information and an active link
(where possible) are included.
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